Active Income vs Passive Income for Service Businesses

In this post, I hope to outline a way of conceptualizing passive income in a way that will help you spend your time creating more of it.

In a service business, all of your income at first is generated actively. Active Income is directly proportional to the amount of time you spend creating it. It is your hourly rate or your day rate. It starts by offering a service to a client. They pay you to spend your own time to do the work for them. After you’re finished and they pay you in full, that particular project relationship is over. No more time spent, no more money earned.

The only two ways to increase your Active Income are:

Spending more time

Earn more money per unit of time

Your time is limited, so #1 has a cap.

Technically #2 is not capped since there is no limit to the amount of money you can earn per unit of time. But past a certain point it gets increasingly difficult to raise your rate per time far beyond the top of your industry, more difficult I would argue than what I’m about to outline below.

Passive Income is not tied to a certain unit of time in the same way as your hourly or day rate. This is the appeal of passive income. Who wouldn’t want to make an unlimited amount of money without trading hours for it?

But this shiny, sexy definition of passive income is distracting.

It’s not that it requires no time spent — rather, that the amount of Passive Income is not proportional to the time spent creating it. It could be millions in a matter of hours. Or it could be nothing for months.

Passive income is created by spending time setting up systems and delegating work. The trouble here is if you’re spending 100% of your time earning Active Income, you’ll need to sacrifice some of that time (and, in turn, some of your income), in order to spend time building the systems that will create passive income, which has a delayed and unpredictable return.

What this looks like practically for me is budgeting about 20% of my time each week to create systems (outline processes, hiring/onboarding employees, etc.). I categorize these tasks as having no direct and immediate monetary return, but they will save me time once implemented properly. That way, I’m always building an income machine that will compound and last over time, not handing in my hours, watching them disappear, and then earning some set amount of money that also will disappear. That’s like going from 0 to 1, back to 0, back to 1, and flip flopping between the two eternally.

The best long-term strategy for making income in business is by spending some amount of time consistently on creating passive income, knowing you won’t see it right away. Build something to last. Without the discipline of doing so, you will be caught in the never-ending cycle of trading your hours for income.